When a Roth Conversion is Right for You

Posted on Oct 5, 2015 4:35pm PDT

3 Enticing Benefits of a Roth Conversion for High-Income Clients

Many retirees are familiar with Roth individual retirement accounts and their advantages. But for those high-income clients who have decided against a Roth conversion, there may be some enticing benefits you have overlooked. First, it should be noted that there are generally two ways to fund a Roth IRA: either by way of a contribution or a conversion. This article shall focus on a Roth IRA conversion which usually comes from a Traditional IRA.

A Roth IRA conversion is a taxable event which creates an income tax consequence for the amount converted in the year of conversion. There are ways to reverse the conversion; but a high-income should do his/her best to plan appropriately so that a reversal will not be necessary. A high-income taxpayer should know that he/she is not required to convert the entire Traditional IRA; but rather, can convert an amount of his/her choosing.

The benefits of a Roth IRA conversion is that there are generally no taxes on the distributions, there is no required minimum distributions and there is no income or age limit on whether you can do the conversion.

As stated, moving funds from a Traditional to a Roth IRA trigger income taxes, some of which may have been deferred for many years! For some high-income clients, that tax bill could wind up being close to 50% when accounting for federal/state/local taxes.

So when should high-income taxpayers consider such a conversion?

If you:

…want to eliminate RMDs for you and pass tax-free distributions onto your heirs

Many high-income investors won't need to draw down on their IRAs and instead consider them as vehicles with which they will pass wealth onto their heirs. Under current law, Roth IRA owners never have to take required minimum distributions. So after enjoying decades of tax-free growth, a conversion allows you to also skip out on required minimum distributions. After inheriting your Roth IRA, your heirs will have to take annual RMDs, but they generally won't have to pay any federal income tax on those withdrawals as long as the account has been open for at least 5 years.

…expect to be in a higher tax-bracket later in life

There are high-income earners that anticipate being taxed at a higher rate when they plan to withdraw from their IRAs. Some tax-bracket changes may be so significant that paying the tax on the conversion now may be more cost efficient than being taxed on withdrawals later. The Roth conversion eliminates federal income tax to the participant on any future withdrawals.

…expect tax rates in general to be higher in years to come

Those high-income taxpayers who are pessimistic about the future of the internal revenue code may also choose to convert their traditional IRAs to Roth IRAs, as today's tax rates may not be as high as those of the near future. Uncertainty in this regard may encourage you to convert today.

In any event, if you are considering a conversion to a Roth IRA and are considered a high-income taxpayer, please feel free to contact us at 516-496-7800 with any questions.